Unemployment Insurance and Credit Frictions

This paper extends the existing literature on optimal unemployment insurance by allowing for self-insurance; individuals may save using a one-period riskless asset, but their access to the credit market is restricted. I show that under this market arrangement, an asset based unemployment insurance scheme implements the optimal allocations. The optimal benefit payments \emph{policy} shows no duration dependence, and relies exclusively upon an individual's current asset position. Benefit payments are decreasing in wealth and, as a consequence, peaks at a constant level when the liquidity constraint is binding. Over the course of unemployment, individuals decumulate assets and the sequence of benefit payments is thus observationally non-decreasing; a result that stands in sharp contrast with the previous literature. In a quantitative exercise it is shown that the US unemployment insurance programme is surprisingly close to optimal for the asset poor, but too generous for wealthier individuals. The potential cost-savings of switching to the optimal program ranges from roughly 33% of the present value insurance budget for the affluent, to 7% for the less fortunate.